Wednesday 25 May 2022

Hello everyone, it is my pleasure to stand before you today at the SSM’s 15th European RoundTable, which shines a light on banking in the new normal.

Before I begin my remarks on the actual topic of stress testing for climate risk and ESG more broadly, I want to underline how abnormal times are at present. For the first time since the end of the second World War, we in Europe are witnessing a war in which millions of people are fleeing their country and seeking refuge with their European neighbors. Of course, as Belgian banking sector we give support where we can, among others by providing dedicated services to help people seeking refuge from the war. Besides the huge human costs, it is also worth noting that the geopolitical and economic consequences of the war have impacted the discourse on climate and ESG.

This brings us to the topic at hand: “ESG: from strategy to practice”.

Sustainability is one of the most important challenges that today’s society is facing. In facilitating the transition to a more sustainable society, the financial sector has a key role to play. It is a sector that will be affected by climate change, but that can also influence the impact of climate change. Taking into account this interdependence and double materiality is an important and unique feature of the EU’s initiatives on sustainable finance. Something that is currently missing from the US approach, for example.

Specifically, we are not only looking at the risks of climate-related events for financial institutions and financial stability. We also look at how exactly the financial sector, through its credit policy, can increase its positive impact on the climate and limit its negative impact. Financial institutions that increasingly focus on ESG will become more resilient to ESG risks and will help protect financial stability. At the same time, ESG creates new opportunities in guiding and financing the development of new sustainable business models and in supporting the transformation of traditional companies. Thanks to the financial sector’s expertise in risk management and its core business of financing, the sector is playing a key role in the shift to sustainability. By the way, I am also convinced that the key role of the financial sector in the shift towards more sustainability will attract the younger generations to work in our sector.  

The integration of ESG into the strategy of financial institutions is not new. In recent years, waves of regulatory and supervisory initiatives have accelerated this process. Initiatives such as the EU Taxonomy, the Sustainable Finance Disclosure Regulation (SFDR), the Pillar 3 ESG disclosures, the ECB guide on climate-related and environmental risks and the recent Climate Risk Stress Test have made the integration of ESG factors into risk management and ESG reporting and disclosure an absolute focus. However, all these different initiatives create an extremely complex framework with many interlocking and interdependent elements. It’s not surprising that there are still many issues to be addressed before the framework can truly be effective.

To make the framework effective, we need to look at the current level of regulatory complexity. In this regard, I would like to cite a quote from Isaac Newton about nature. I think therein lies an often neglected fact: “Nature is pleased with simplicity. And Nature is no dummy”. Simply put, if we want to be successful, our regulations must be stable, transparent and as simple as possible. I believe progress can still be made in this area. One way to achieve greater simplicity is to avoid regulatory fragmentation. We need to move towards a global, common approach to regulation, consistent reporting standards, climate scenarios and stress tests.

Sustainability is also about networks. To make the right assessments and take the right decisions, we cannot look at banks or companies in isolation: we need information on the broader value chain. Moreover, we must not only look at past performance but also consider transition strategies, future scenarios and long-term horizons. This implies involvement and a permanent dialogue between the different actors in the network: companies, investors, banks and public authorities. We must never forget that the road to a sustainable economy is a long and winding one that we all must walk together. But how do we do that?

Apart from transparency and simplicity, the  regulatory framework needs to be more consistent in its definitions and data. A common approach to methodologies, scenarios and  timelines must be agreed upon. Then, there are practical steps – such as adapting internal IT systems or collecting data – that will take time to implement. In short, to successfully implement the sustainable finance framework, we need consistency, data, and time.

• For financial institutions, high-quality data on ESG risks and ESG performance of the projects they finance are crucial. For example, it is unrealistic to expect immediately useful and actionable results from climate stress tests if the data on which they are based on are fragmentary, unrepresentative and of uncertain quality. Until this data problem is solved, stress tests are no more than a valuable learning exercise for both banks and supervisors that provides indicative results and a basis for further refinement.

• Banks rely heavily on the information disclosed or provided by their clients, and at present there are some acute challenges with respect to smaller companies and non-public companies. In Belgium, most of the professional clients are SMEs, and these make up the majority of banks’ balance sheets. Such smaller unlisted companies typically do not provide publicly available information and may not even report this information internally. While the lack of ESG data should not be an excuse for inaction, we are concerned about the data issues and costs that banks will face in trying to measure and manage their climate-related risks and provide reliable information. To compensate for the lack of ESG data, proxy data and estimates will be inevitable as long as reliable primary data are not available. Moreover, easy access to ESG data stored in public databases, such as EPC certificates, would support our efforts. Real coordination between all actors (banks, governments, companies and different regulations) is what is really and urgently needed here.  

• In practice, the absence of an economy-wide disclosure requirement that includes all private companies, could lead to banks being put in the position of being the primary enforcers of climate policy. Not only is this an inappropriate delegation of responsibility, it is also one that many banks are in no position to assume.

• It is true that financial institutions have a responsibility to properly integrate climate risk into their risk management systems. They should however not be made responsible for enforcing ESG reporting by their clients. Banks are not the ESG police, but rather a guide and facilitator in supporting their clients in the transition towards more sustainable business practices. Each actor in the network must play its own role ant take its responsibility. Banks cannot be left alone to enforce ESG reporting.

• Therefore, partnerships between companies, banks and government are essential. Each partner, within its domain of responsibility and leverage, supports and reinforces the actions of the others. And indeed, the financial sector has a key position as a facilitator of change. But the sector alone will not save the planet. Banks cannot drive the transition of the economy on their own. It is not by pointing fingers to the banks and shifting responsibilities that we will address social and environmental problems. Clients, financial institutions, supervisors and regulators have to work together and support each other in this extremely difficult task to make the transition a success.

• But also the governments have their role to play. To bring about meaningful and impactful change, we need clear and ambitious government choices based on a long-term vision. Governments must adopt bold policies that encourage all sectors and businesses to move forward with the transition. In doing so, we will create an economic environment that promotes, encourages and rewards sustainable business. This way, the sustainable choice will also be the most profitable choice. European and national policies should structurally encourage sustainable choices and investments by companies and financial institutions. This task and responsibility cannot be outsourced.

• As I said earlier, the road towards a sustainable economy will be a long and winding one that we have to walk together. The financial sector is determined to take responsibility. It is investing heavily in adapting IT systems and adjusting internal procedures for risk management and credit approval. Not with the aim to produce white noise, but to provide substance in the current situation of limited information and incomplete frameworks.

In conclusion, let’s not forget that ESG reporting and risk management alone will not be enough to mitigate climate change, adapt to inevitable climate events and deal with societal impacts. In the challenging journey from ESG strategy to ESG practice, we must keep in mind the ultimate goal of the sustainability agenda. And that is not ESG risk management nor ESG reporting. It is about an economy that is consistent with the well-being of the planet and all the people living on it. As a financial sector we are uniquely positioned to help achieve this goal. Through our core activities, we can act as a catalyst for a sustainable transition and long-term value creation for society. It is indeed an exciting time to be working in the financial sector. Thank you.

Karel Baert, CEO Febelfin